#107 | Why you should reject Dave Ramsey’s Debt Snowball Method, and what to do instead

July 26, 2021

Episode Summary:

 

In this week’s episode, we talk about one of the most popular debt payoff strategies, Dave Ramsey’s Debt Snowball Method. It’s been around for a long time and has helped many people get rid of their debt. But this doesn’t mean it’s the best strategy for paying off your debt and maximizing your financial recovery. We discuss our thoughts on this method and explain why you should ignore it. And then provide you the reasons why a different method is better! 

 

Episode Notes:

 

Dave Ramsey is an ultra-popular guru for personal finance, but his advice and style are divisive. In episode 93, we talked with Haley and Justin from the Price of Avocado Toast podcast, who hate the guy. But millions love him. What he might be best known for is his Debt Snowball Method for becoming debt-free.

 

Here’s how it works from his website:

 

Step 1: List your debts from smallest to largest regardless of interest rate.

Step 2: Make minimum payments on all your debts except the smallest.

Step 3: Pay as much as possible on your smallest debt.

Step 4: Repeat until each debt is paid in full.

The strategy here is psychological more than financial, and that’s where we take issue. Ramsey argues that you need momentum to pay off debt. But this comes at the expense of higher costs. So we recommend you should instead pay down your highest interest rate debt first.

 

If you’re listening to Ramsey or this podcast, you have motivation. It might not be strong yet, but it’s there. The way you gain momentum, in our opinion, is to grow that net worth every month! 

 

Hear us out:

 

Download our net worth tracker and list out your debts. If you have $10,000 of debt at 20% and $1,000 at 2%, you’re paying $2,000 in interest on the former; on the latter only $20. When you are tracking your net worth, you will see those numbers. And if you are paying down the higher interest rate, your net worth will be growing faster because you are eliminating more costs and saving more money.

 

Paying $100 off on the first loan saves you $20 a year in interest. On the other hand, $100 on the smaller loan saves you only $2 a year. Which of those cost savings is more motivating?

 

Here is the process we instead recommend for paying off your debt:

 

Step 1: List your debts from smallest to largest interest rate. 

Step 2: Make minimum payments on all your debts except the highest interest rate.

Step 3: Pay as much as possible on that highest interest rate.

Step 4: Repeat until each debt is paid in full.

Let’s also talk about high interest and low-interest loans over the long term. High interest is devastating to your net worth. We’re talking about anything over 5%. So don’t sign up for it! Get out of it ASAP. It will kill your finances. But low-interest-rate loans you can look at differently. This isn’t to say that you should get them or keep them, but if you have them, think about the trade-off.

 

If you have student loan debt at 2% and you’re not contributing to your 401k, don’t pay down the debt just yet! You’re missing a 100% ROI on that match. You do need to get rid of that debt, but do the 401k first and then start cutting your living expenses elsewhere to pay it off. Paying off debt needs to be analyzed within the framework of your total net worth.

 

Top 3 takeaways:

  1. Dave Ramsey is mainstream, and therefore his advice might not always be golden.
  2. Pay down the highest interest rate loans, not the smallest. Your net worth will improve faster.
  3. Avoid debt as much as possible, but think strategically about the opportunity cost for paying down the lowest interest rate loans if you have debt.

 

Show references:

You may also like…

FOLLOW friends on FIRE